Bitcoin, Cash And Tax Implications

By Jerry Mooney

Is it a problem that Bitcoin is a cryptocurrency and therefore makes all participants unknowable? On one hand, it creates a sophisticated solution to the rise of cybercrime worldwide. However, it's opaque process also makes it a vehicle to potentially circumvent taxation as well as a prefered currency on the black market. Because the Bitcoin ledger is completely open, all transactions can be seen by anyone. However, the participants in those transactions are completely masked by encryption.

Instead of using personal data and identifications, the Bitcoin network uses long-string mathematical identification, which makes individual discovery virtually impossible. This means that Bitcoin transactions, although open, operate much like cash at a yardsale. This separates if from other forms of electronic payment system like Paypal or DIY E-payment.

It is unlikely that there will be sales or income tax reported for the event. However, this yard sale is happening worldwide with billions of dollars worth of exchanges. According to Villanova University, tax law in 2016 will include new provisions regarding Bitcoin and taxes. These new laws have a couple of issues working against them. First, because of the encrypted nature of Bitcoin, taxation would exist largely on the honor code. People would have to come forward with their Bitcoin earnings.

There is the possibility that when Bitcoin are exchanged for dollars that those earnings could be tracked like stocks, but that only accounts for capital gains, and the origin value would be difficult to established which is required for capital gains. Additionally, if the Bitcoin is mined, then there would be a need to offset the cost of mining, i.e. electricity, hours etc. However, capital gains have no tax caveats for such writeoffs. Secondly, the tax code is trying to play it both ways. Bitcoin is a commodity and a currency. By being currency it is subject to income tax, but by being a commodity it is capital gains. By declaring it a currency for tax purposes puts it in a bind as to how currencies become legitimate and is resisted strongly by the Central Banks. This classifications suggests that fiat currencies are not the only method of modern currency creation. Nonetheless, transactions are occurring using Bitcoin which makes it ultimately legitimate based on economic validation rather than central authority. As this continues and grows, so does the currency's legitimacy. Additionally, as the Bitcoin marketplace expands, there is less and less necessity in exchanging Bitcoin for dollars, thwarting the only real available tracking option.

Whether it is currency or commodity, it operates much like cash. This is where many of its opponents find their stance. Like cash (with some obvious exceptions), it cannot be traced. This makes underground, illegal and subversive transactions possible. But this is not unique to Bitcoin. People have been using different forms of currency and commodity to conduct illegal activity forever. Beyond cash, diamonds and other fungible commodities are often used to hide the identities of those engaged in commerce. What Bitcoin brought to the table is that it is digital and transactions can be made almost instantaneously. This does create a new level of problem for law enforcement and taxation, but these problems aren't new.

Bitcoin only adds a new wrinkle to the challenge. And the problems must be addressed on their own merits. Bitcoin didn't create the underground economy and its purpose is not to solve the problem or add to it. It is merely a quality means of transacting, which the underground economy recognizes. What's become clear, however, is that Bitcoin's legitimacy is now acknowledged in the marketplace as well as legally, even if that was never the intention. But if you use Bitcoin, don't be surprised if Uncle Sam expects you to fess up and pay your tax bill.